Quantile Graphical Models: Prediction and Conditional Independence with Applications to Systemic Risk

TL;DR

This paper introduces two types of Quantile Graphical Models (QGMs) for analyzing complex dependence structures and conditional independence in high-dimensional, non-Gaussian data, with applications to systemic risk and financial contagion.

Contribution

It develops novel estimation and inference methods for high-dimensional QGMs, including CIQGMs and PQGMs, with theoretical guarantees and applications to tail risk networks.

Findings

QGMs effectively model tail interdependence and systemic risk.

Methods provide valid confidence regions and handle high-dimensional data.

Application to financial contagion enhances understanding of downside market risks.

Abstract

We propose two types of Quantile Graphical Models (QGMs) --- Conditional Independence Quantile Graphical Models (CIQGMs) and Prediction Quantile Graphical Models (PQGMs). CIQGMs characterize the conditional independence of distributions by evaluating the distributional dependence structure at each quantile index. As such, CIQGMs can be used for validation of the graph structure in the causal graphical models (\cite{pearl2009causality, robins1986new, heckman2015causal}). One main advantage of these models is that we can apply them to large collections of variables driven by non-Gaussian and non-separable shocks. PQGMs characterize the statistical dependencies through the graphs of the best linear predictors under asymmetric loss functions. PQGMs make weaker assumptions than CIQGMs as they allow for misspecification. Because of QGMs' ability to handle large collections of variables and focus on specific parts of the distributions, we could apply them to quantify tail interdependence. The resulting tail risk network can be used for measuring systemic risk contributions that help make inroads in understanding international financial contagion and dependence structures of returns under downside market movements. We develop estimation and inference methods for QGMs focusing on the high-dimensional case, where the number of variables in the graph is large compared to the number of observations. For CIQGMs, these methods and results include valid simultaneous choices of penalty functions, uniform rates of convergence, and confidence regions that are simultaneously valid. We also derive analogous results for PQGMs, which include new results for penalized quantile regressions in high-dimensional settings to handle misspecification, many controls, and a continuum of additional conditioning events.